I probably picked on Anna Schwartz enough last winter, but since readers keep sending me her new editorial in the NYT, I suppose I should say something.  Here is her explanation for why monetary policy was easy last fall:

Let me begin with the former. It is standard practice for a central bank like the Federal Reserve to ease monetary policy to combat a recession, and then to tighten it as recovery gets under way. Mr. Bernanke so far has only had to do the first half, and has conducted a policy of extreme ease. The Fed’s Open Market Committee cut the federal funds rate in October to 1 percent from 1.5 percent, and then in December to a range of zero percent to 0.25 percent.

Extreme ease?  If this quotation sounds familiar, it may be because the argument used is essentially identical to an earlier Joan Robinson analysis of the German hyperinflation:

“An increase in the quantity of money no doubt has a tendency to raise prices, for it leads to a reduction in the rate of interest, which stimulates investment and discourages saving, and so leads to an increase in activity.  But there is no evidence whatever that events in Germany [in the early 1920s] followed this sequence.”

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My view of the period from mid-2006 to mid-2008 is as follows:

Too much capital was allocated into housing during 2004-06.  After the U.S. housing market peaked in mid-2006, for the next two years we had a mildly painful readjustment, as resources were moved out of housing and into other sectors of the economy.  Because it is difficult to re-allocate resources, the structural unemployment rate crept up from the mid-4s in mid-2007 to the mid-5s a year later.  Other sectors of the economy kept growing.  There were no signs of bubbles in U.S. manufacturing, which grew at the normal rate during the previous expansion, and of course manufacturing prices were well-behaved (unlike housing.)  The big bubble was in housing, and after 2006 we had to go through a painful readjustment as labor and capital was re-allocated to other sectors.

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One can learn a lot about monetary theory from studying either commodity standards or fiat money regimes.  But perhaps the most illuminating examples come from an in between system, a transition from one commodity regime to another.  Although most of this (very long) post will seem far removed from current issues, in the end I will argue that there are important lessons.  We will look at 1933, the year of transition from one gold standard (1879-1933) to another (1934-68.)

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I’m certainly no expert on Austrian economics, but I have always viewed Friedman and Schwartz’s Monetary History as a sustained attack on both the Austrian and Keynesian views of the Great Depression.  Now we have a revival of the Austrian view from an extremely unlikely source.  Before considering her arguments, let’s first look at the F&S analysis of monetary policy during an asset price bubble.

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